a37172 Pensions Brochure single pages LR

Humanising pensions
Understanding the behavioural effects
of freedom in pension choice
A Summary of

3 Foreword
4 The retirement puzzle
6 Behavioural barriers
8 The government response: a landscape of nudges
9 Unintended consequences
10 The new DC landscape: how much choice is dangerous?
13 Potential behaviours
16 What is the right answer?
18 About the authors
• Because increased choice over how pension benefits are taken in the UK has created a raft
of new behavioural complications for members
• Because only by understanding the types of behavioural responses members will have,
can employers plan for the impact on their workforce and pension arrangements
• Because it provides practical suggestions on what steps employers and trustees can take
to aid employees in decision-making.
Contents
2
Why read this report?

These changes have not only made an already
complicated landscape even more challenging
for employers and pension trustees, but for the
employee, squeezed between concern about
current day-to-day finances and funding their
future retirement, a fiendishly complex and
daunting set of decisions just got so much worse.
Despite evidence that a majority of savers are
broadly in favour of more financial freedom, there
is concern that too much choice could overload
people and leave them less likely to find a good,
or even suitable, solution. We therefore ask the
critical question: how much choice is dangerous
and how can this be managed?
This report marries together our behavioural
finance insights with our experience of pensions
consulting, to help explain the role that targeted
financial support can play. The fact that people
welcome automatic enrolment suggests that
there is a broader function for well-thought-out
‘nudges’ that take the onus off the individual
to make financial decisions but, importantly,
well-designed engagement programmes that
go ‘beyond nudge’ to help them to feel more in
control of their own future.
Our previous report Steps Towards a ‘Living
Pension’ showed that employees are hungry for
help with their financial planning. Over three
quarters would simply welcome personalised
emails about their pension and what they stand
to lose by not contributing. So there is real
opportunity to support people now with
interventions in the workplace towards their
retirement ambitions.
Moreover, organisations can benefit from
focusing greater attention on their employees’
financial well-being than they do currently.
Employees do not leave their financial worries
at the door when they arrive at work; we have
found that the impact on company performance
through engagement and productivity is greater
than most realise, totalling 4% of payroll.
Our intention is that the insights included in this
report will help employers to improve their work-
place pension and benefits offerings, and enable
good employee outcomes from their schemes. In
using our behavioural finance expertise to examine
the psychology behind financial decision-making,
we identify the knowledge and tools required to
enable employers and their workforces to provide
for their future, and enable more confident and
informed retirement decision-making.
Greg B Davies, PhD
Managing Director
Head of Behavioural and Quantitative
Investment Philosophy
Barclays Wealth and Investment Management
Lydia Fearn
Head of Investment Consulting
Corporate and Employer Solutions, Barclays
The last few years have seen unprecedented change in workplace
pensions in the UK. From the removal of a mandatory retirement age
to the introduction of auto enrolment, and from the retail distribution
review to new freedom and choice measures last year, the pensions
market has undergone a fundamental shift.
Foreword
3

Instead, in defined contribution (DC) schemes,
which are now the standard, the employer
contributes a set amount, together with
contributions from the employee, but bears no
further liability if investment performance is poor.
All the pension risk is borne by the employee.
Combined with the fact that state pension
benefits will not fund the kind of lifestyles that
people aspire to in retirement, this makes the
choices each investor makes with regard to their
DC investment critical to the retirement lifestyle
they will experience.
Unfortunately, most of us are not very well
equipped to assess whether we are on track for
the type of retirement we want. A report from
Aviva and Deloitte published in 2010, based on
top-down analysis, stated that the gap in
accumulated contributions in the UK for those
people retiring in the next 40 years is £317bn.
Their analysis was skewed by the small number
of members very close to retirement with little
or no savings, so the headline figure quoted,
that on average a further £10,000 contribution
per person, per year is required to close the gap,
is misleading. Focusing instead on those aged 50
at the time, the equivalent figure from the report
is an extra £6,200 per year until retirement.
In our recent publication Steps Towards a ‘Living
Pension’, we asked different generations to define
their must-have retirement income, the ‘living
pension’, and compared this to their projected
pension at retirement1
. The results supported the
general finding in the Aviva and Deloitte study
and showed that, on average, all generations
need to contribute more just to arrive at their
living pension. For the baby boomer generation
(those born between 1945 and 1960) this
additional contribution amounted to 26% of
their annual salaries, and even then they still
needed to work five years beyond their intended
retirement date.
Further complicating the issue of saving for
retirement, the recent pension reforms have
significantly changed the DC pension landscape.
Now, in addition to the behavioural concerns of
people not saving enough for retirement, the new
legislation has given people complete freedom of
choice over how they take and use their pension
benefits. This adds a raft of new, and very
different, behavioural complications.
Hitherto, most people retiring, except those with
either very small or very large pension pots, had
no choice but to buy an annuity. Now they are
given the freedom to select from a wide range
of actions, which fit into four general categories:
1) buy an annuity product; 2) remain invested in
a portfolio and use income and/or capital to fund
In recent years shifts in pension provision have transferred risks
from employers to employees. Many older employees have a
defined benefit (DB) pension that does precisely what the name
suggests – it pays a defined amount in retirement.
The retirement puzzle
1. Buy an
annuity
product?
4. Combination
of 1, 2 and 3?
2. Remain
invested in a
portfolio?
3. Withdraw
the whole
fund in cash?
4

retirement (drawdown); 3) withdraw the whole
fund in cash (subject to paying income tax);
or 4) some combination of these.
There is real concern that retirees may simply
choose to spend the money earlier than they
would have been able to under the previous
system. The first major difficulty we all face is
estimating how long we will live in retirement.
We may look at relevant data points like mortality
rates or, more specifically: at the age our parents
lived to, whether we worked in strenuous,
physical jobs that could have affected our health,
or whether we have had any major illness in
earlier life. Almost certainly we will underestimate
the progress that medical science will make in
keeping us all alive for longer, significantly
increasing the chance that we will run out of
retirement savings before we pass. Now, more
than ever, the choices we make throughout our
working lives to build our pension savings, and
into retirement regarding our spending and
standards of living, will be hugely important.
In recent years, the UK government has
taken major legislative steps to make some of
the most sweeping changes to the pensions
landscape we have ever seen. These steps are
built on the best intentions to achieve better
outcomes for its citizens. Yet it is interesting
to reflect that, from a behavioural perspective,
the approach taken to achieve these outcomes
is not always as consistent as it could be. With
that said, there is a clear recognition of the
importance of behavioural finance. The FCA’s
latest report, for example, acknowledges how
an understanding of decision science provides
insight into the likely outcomes of the decisions
people take.
Given the current landscape it is crucial for
employers to understand and appreciate their
role in helping employees provide for retirement.
This includes, but is not restricted to, the
investment options for employees and the
appropriateness of default solutions.
The
retirement
puzzle
and behavioural barriers Lack of
urgency
Underestimating
the effect of
compounding and
benefits of tax relief
How much money
will I need for
my retirement?
Lack of
awareness for
the need to save
Current self
and future self
Pension
New car
Why?
Z Z Z
?
1
Based on current pension fund balance and current contribution levels.
5

This is a particularly big problem for those with
low levels of numeracy and education, which
are strongly linked to lower retirement savings
and lower use of investment products2
. The
complexity of the problem, and not knowing
how to approach the many choices involved,
can also be off-putting for many, leading people
to bury their heads in the sand.
How do you know how much money you
will need in retirement?
The answer to this is the most basic building
block of a sensible solution, but we find it very
difficult to put ourselves in the shoes of our
future selves. We struggle to perceive the
importance of, and particularly to quantify, our
future needs such a long time in the future.
Translating these into requirements for our
present selves is a tall order.
Another important factor is the lack of urgency
people exhibit – there is always something more
pressing than planning and saving for retirement.
We become focused on the more immediate
issues in our lives and this ‘tunnelling’ leaves us
little bandwidth to spare on planning for our
future. Let’s consider an example. There will be
many non-retirement goals that are important in
earlier life, such as saving for a home deposit,
which will conflict with saving for retirement.
Achieving these goals fills the ‘tunnel’ of issues
that you have the cognitive capacity to cope with
thinking about. You might recognise that
retirement planning is important but it is just not
in the tunnel and consequently it doesn’t receive
any of your bandwidth. This is a situation that
might last many years as more pressing and
urgent goals continue to fill the tunnel. After
all, we can always start thinking about saving
tomorrow once we have taken care of whatever
is front of mind.
Saving for retirement is how you transfer
money from your current self to your future
self. However, this also means you are probably
transferring the happiness derived from
consumption from your current self to your
future self. This is a trade-off that needs to feel
worthwhile, but we humans are not very good
at making such inter-temporal judgements, as
illustrated by a study of students at a top US
university3
. They were asked to predict how
much a USD$400 monthly contribution would
be worth if compounded annually at 10% for
10, 20, 30 and 40 years. Figure 1 shows the
predictions versus the actual calculated value
through time. The average predicted value
after 40 years was around $250,000, whereas
the correct value is closer to $2.5m! A set of
participants were even given calculators to help
them calculate the value, which didn’t materially
change their estimates.
Underestimating the effect of compounding
means people are much less likely to save. If you
think those contributions give you a $250,000
pension pot, which might provide an income of
about $980 per month4
, then delaying your
consumption happiness by 40 years for such a
small increase ($400 only buys you $980 in
retirement), may not be that appealing.
There are many reasons why we find it hard to save for retirement,
something that is a long way off for many. Perhaps one of the most
pertinent barriers to retirement planning is a lack of awareness of
the need to save, especially in the early stages of working life.
Behavioural barriers
6

We have inaccurate perceptions about the
incentives to save for long-term goals. In reality,
the $2.5m of savings provides a much more
valuable income (more like $9,800 a month) and
greater level of consumption in retirement that, if
correctly estimated, should encourage much more
saving. All of this leads to the commonly expressed
attitude of ‘I am too young to start saving for
retirement’, when the more accurate phrase, at
almost any age, would be ‘I am too old not to’.
In addition to underestimating the power of
compound interest, people underestimate the
benefits of tax relief and employer-matching
incentives – ‘free money’ which increases the
amount contributed. A reduction in take-home
pay of £100 would give rise to a pension
contribution of £125 for a 20% tax payer and
£167 for a 40% tax payer where the employer
deducts pension contributions from gross pay.
Any employer-matching will then increase
contributions further. Failing to consider these
will lead to further underestimation of how
much future value each contribution creates.
Years in the future
Actual
Estimate
Figure 1
Underestimating the power of compounding
Source: Mckenzie, C.R.M., Liersch, M.J. (2011) Misunderstanding
Savings Growth: Implications for Retirement Savings Behavior,
in Journal of Marketing Research: November 2011.
2
Banks, J., Oldfield, Z. (2007) Understanding Pensions: Cognitive function, Numerical Ability and Retirement Saving,
in Fiscal Studies, Volume 28, Issue 2, pp.143-170.
3
Mckenzie, C.R.M., Liersch, M.J. (2011) Misunderstanding Savings Growth: Implications for Retirement Savings Behavior,
in Journal of Marketing Research: November 2011, Vol. 48, No. SPL, pp. S1-S13.
4
Assuming a 4.7% rate (indicative for level rate with no guarantee at age 55) means USD$250,000 will buy an annuity
of USD$979 per month.
7
Medianpredictedvalue(indollars)
2,500,000
1,500,000
2,000,000
1,000,000
500,000
10 20
0
2,500,000
1,500,000
2,000,000
1,000,000
500,000
10 20 30 40
0

When attempting to alter behaviour we have a range of options:
deliver education, provide a subtle nudge, or provide a strong shove
in the right direction.
The government response:
a landscape of nudges
For years government, the pensions industry and
financial advisors have attempted to educate
people on the benefits of saving more for their
retirement but with little success. It seems inertia
trumps education.
In the physical world, inertia is the resistance
of an object to any change in its state of motion.
This concept of moving in one direction unless
a force is applied has parallels to the way we
behave in decision-making, and is often called
the ‘status quo bias’. The number of consumers
who stick with products and services despite poor
outcomes has been shown through numerous
studies. These studies suggest this is largely
because making any change requires an amount
of effort, mental or otherwise, deemed too high
to overcome. This inertia, which often defines
how we behave and make choices, has significant
consequences for pension scheme members.
The government’s approach to overcome this
inertia and address the increasing shortfall in
DC pensions has been, increasingly, to legislate
rather than educate. The first part of this
legislation was auto enrolment, leaving
employees automatically enrolled into a pension
scheme which is subsequently invested into a
default fund. Here, the power of inertia is being
harnessed in people’s favour. The status quo bias
makes it likely that most will remain contributing
into the default fund, and the early results from
companies that have staged auto enrolment
support this observation: they show a marked
increase in the participation in workplace pension
schemes5
. Enrolling employees by default is
a good first step to help people provide for
retirement. However, the current one-size-fits-all
levels of saving may not be sufficient for most.
The government, by introducing auto enrolment,
is attempting to help employees overcome
behavioural barriers, but this does not mean that
employers can absolve themselves from thinking
closely about pension provision for their staff. We
examine some interventions which employers
could use to counteract these barriers to saving
in our guide Steps Towards a ‘Living Pension’.
5
Automatic enrolment opt-out rates: findings from research with large employers, https://www.gov.uk/government/
uploads/system/uploads/attachment_data/file/227039/opt-out-research-large-employers-ad_hoc.pdf
I haven’t got time
now, I will do this
another day
8

Auto enrolment brings many benefits: the largest is to society as a
whole because more people save, thus improving retirement lifestyles.
Unintended consequences
This is followed by the individual benefit to those
who wouldn’t otherwise save for their retirement.
However, auto enrolment is not necessarily a
silver bullet. Greater participation and, due to the
same inertia, greater numbers invested in the
default fund increase the importance of having
an appropriate strategy. But default funds are
designed for the average, and to safeguard those
worst off. This means that, while they may be
roughly appropriate for many, they are not a
perfect fit for most, with those who are very
different from the average getting a particularly
bad fit.
As with most interventions or nudges, auto
enrolment will have a positive effect for those
who would otherwise be unengaged. However,
it may actually discourage further engagement
by leading people to take the position that
‘someone else has thought about this for me’,
taking us even further away from the goal of
‘confident and informed’ decision-making.
Nudges are an essential safety net to improve
outcomes for those who can’t or won’t engage,
but need to be supplemented by other measures
to promote engagement, or they might have
unintended negative consequences – including
feeling overly-comfortable with an inadequate
solution.
To highlight these risks consider the results of
a study in the US which showed the effects of
auto-enrolment on contribution rates (Figure 2):
employees anchored strongly on the 2% default
contribution rate, with few deviations. Under
auto enrolment more employees joined. However,
there had also been a reduction in the number of
employees contributing more than the default.
The power of inertia is plain to see here, but
actually works against those employees who
would otherwise have thought about how
much to contribute. Removing the decision to
join removed the need to think about the right
level of saving.
1% 2% 3-5% 6% 7-10% 11-16%
3 1
6
20
67
9
17
7
26
37
14
31
14
6
18
9
4
10
80
70
60
60
40
30
20
10
0
Percentageofparticipants
Contribution rate
Figure 2
Unintended consequences of auto enrolment
Source: Choi, J.J., Laison, D., Madrian, B., Metrick, A. (2001) For better or for worse: Default effects and 401(K) savings behaviour,
in Wise, D.A. (2004) Perspectives on the Economics of Aging. University of Chicago Press; p.81-121.
Hired before automatic enrolment
Hired during automatic enrolment: 2% default
Hired after automatic enrolment
9

After April 2015 retirees will have huge amounts of flexibility over
how they take their pension benefits, which most did not have
previously. This newfound freedom of choice raises some important
behavioural issues.
The new DC landscape:
how much choice is dangerous?
People will face some of the same issues
discussed in the previous section with regards
to the spending-versus-saving trade-off. The
importance of self-control and retirees’ ability
to delay gratification will be increased and will
have a large effect on retirement outcomes.
It is perhaps worth highlighting the extreme
dichotomy between the behavioural assumptions
underpinning auto-enrolment versus those
underpinning the new freedom of choice model.
Auto-enrolment is based on the behavioural
assumption that savers cannot individually make
the choices that are best for their future selves,
so we must legislate to protect them. The latest
changes in regulation, providing choice at
retirement, are based on a different assumption
entirely: that by retirement investors have
somehow acquired the ability to assimilate large
amounts of complex information and make
optimal decisions for their finances in retirement.
Clearly, there is a degree of inconsistency here in
the behavioural assumptions underpinning these
two legislative changes, and recognising this can
help us understand the potential pitfalls of each.
To begin with there are fears that putting the
decisions and hence the risks in the hands of
employees will lead to many making poor
choices, which could result in very unfavourable
outcomes. The biggest concern is that people will
not balance the spending-now-versus-spending-
later trade-off, and spend their pensions too
quickly, finding that they do not have enough to
fund their standard of living in the longer term.
The risk of too much choice
There is also the risk that too much choice could
overload people and put them off finding a good
solution. Given more options, people are less
likely to make a decision at all, let alone an
informed decision6
.
10
AUTO
ENROLMENT
‘Someone else
has thought
about this for me.’
?

There will now be a huge number of choices
available at retirement. As previously discussed,
there will be three broad ways to access your
pension funds but any combination of these will
probably be available, in many variations, hugely
compounding the problem of knowing what to
do. All these potential problems stem from the
risk that, due to auto enrolment, most employees
will simply not be engaged enough with their
retirement planning to make the sort of decisions
required without assistance.
Free guidance
The government has announced that there
will be free guidance available for everyone at
retirement. This service is branded ‘Pension Wise’
with the slogan Your money. Your choice. and will
be provided by impartial third parties. Behavioural
Finance can give us some insight into how the
mechanism for receiving the guidance, and
the way it is delivered, will affect 1) people’s
likelihood of accessing the guidance and 2)
the actions they will take.
It is an effect of inertia that people take the path
of least resistance and are therefore unlikely
to change behaviours easily. This is what
makes imposing default options an appealing
behavioural intervention. As the guidance is
not mandatory, merely receiving it already
requires effort to move away from the default
of doing nothing. Providers are required to
‘signpost’ members to the guidance, but unless
appointments are made on behalf of members
or they are pro-actively contacted, the action
sits with the retirees and this will reduce
uptake. Therefore, the real impact may depend
strongly on the details of how these sessions
are organised.
The delivery of the guidance then is crucial as,
if not appropriate, it will further reduce the
likelihood people will actually use it. It has been
revealed that the guidance sessions will take
place in person or over the phone, and there will
be online delivery to support this. This proposed
multi-channel delivery will allow people to
engage at a level they feel comfortable with,
which may help address the issues of retirees
not wanting to seek face-to-face consultations
to avoid perceived embarrassment about their
pension savings. Employees expect employers to
help and support their journey to a comfortable
retirement7
, so it may be incumbent on
employers to promote access to the guidance
or advice not only at retirement, but also earlier
in the pension life cycle.
11

6
Iyengar, S.S., Gur Huberman Jiang , W. (2004) How Much Choice Is Too Much: Determinants of Individual Contributions in 401k
Retirement Plans, in Olivia S. Mitchell and Stephen P. Utkus, eds, Developments in Decision-Making under Uncertainty: Implications
for Retirement Plan Design and Plan Sponsors, 83–95. Oxford: Oxford University Press.
7
Financial Well-being: The Last Taboo in the Workplace? Barclays, April 2014.
Guidance standards
The FCA has been tasked with creating standards
for the guidance and, while the standards are not
yet finalised, the details released, by HM Treasury
in January 2015 provide good insight into the
likely content of the guidance. Some of the
original objectives are:
• “It is intended that the guidance will signpost
people to additional specialist help where
appropriate, including, for example, regulated
financial advice or debt advice.”
• “To be effective the guidance will need to be
tailored, providing consumers with sufficient
personalised information, so that they can
understand their options and make confident,
informed decisions about their retirement
choices.”
• “The guidance is not intended to stray into
areas such as specific product or provider
recommendations, which would be better
handled by an authorised IFA. Therefore,
the guidance will not tell consumers which
option to choose or recommend a particular
product, provider or adviser. Ultimately,
consumers will be responsible for
the decisions they make.”
Guidance, then, will clearly consider what the
available options are for retirees. But without
giving any financial advice, it will be difficult to
personalise the description of these various
options and tailor guidance to specific circum-
stances. This implies that retirees will need to be
directed to regulated financial advisors who can
provide this specialist tailoring, leaving a very
small area in which the guidance will operate and
a danger of minimal personalisation. So, while
guidance should help people avoid very bad
outcomes, we think the question of what is the
best solution for retirees still remains.
In the next section we discuss the options and
behaviours of different groups and how these
decisions may be influenced independent of
the guidance.
12
DON’T
FORGET
Make your
own informed
decision.
GUIDANCE
ONLY
Regulated advice
More information
Debt advice

In order to examine the effects of the new freedom on behaviour it
is best to split the choices into two distinct issues: firstly the choice
between one lump sum payment and a stream of payments, and
secondly the choice of how to provide the stream of payments.
Potential behaviours
We will take a further look at each of these issues
before discussing our expectation of behaviours
across UK retirees.
A bird in the hand is worth two in the bush
Framing is an important factor affecting people’s
choices, as decisions can be strongly influenced
by how information is presented. This choice
of how to present information will be very
powerful in determining the choices made.
When comparing a lump sum versus an annuity
(a stream of income payments over time) that is
financially equivalent, humans exhibit preferences
that are not always optimal8
. At lower values,
lump sums are generally assessed as being better
than annuities; but at higher values of wealth the
assessment reverses. This may lead those who
are retiring soon, the generation with smaller DC
pension pots, towards choosing the lump sum
rather than an annuity, even where this is the
worse financial choice for them. This attraction
of ‘cash in the hand’ may also lead to suboptimal
behaviour when choosing between a lump sum
now versus the income from drawing the portfolio
down over time – causing investors to downplay
the capital and potential appreciation in a
portfolio over time. Framing effects could work
to counteract or magnify these effects and
change the outcomes for retirees.
Many comparisons have been drawn with the
Australian system where the flexibility in
pensions is well established and the DC market
is significant, making up 84% of total pension
assets9
. Attention has been drawn to the fact
that close to half of those who accessed
superannuation funds (the Australian equivalent
to DC funds) in 2012 opted for a lump sum
withdrawal and 25% will exhaust their superan-
nuation funds by the age of 70. This dash for
cash is predictable and a potential issue for the
UK, which we will discuss in more detail.
However, this comparison is not completely
reliable as there are some key differences
between the UK and Australian pension land-
scape. Primarily, Australian state benefits are
asset-based means-tested, so they provide some
incentive for people to consume their DC pension
savings, whereas the UK will operate more like a
fixed level state pension.
How will members take their income?
After April 2015, if members want to receive
income in retirement they will have the choice
to annuitise or withdraw income gradually
from their pension fund to meet expenditure
(drawdown). In drawdown there is a risk both
with respect to the amount of income provided
and the length of time it will last for. The exact
risks will depend on the investments in the fund.
CASH
LUMP
SUM
ANNUITY
vs
?
13

14
Despite the risks, many are likely to find the
drawdown option preferable to annuities, with
the possible exception of those with very low risk
tolerance. This is partly because annuities have
had a great deal of bad press, largely due to their
perceived high cost, that will be in the front of
people’s minds. Furthermore, annuities don’t
provide the flexibility for individuals to leave a
bequest, which many will find off-putting. The
trends in countries which have already made
pension reforms similar to those proposed
further support this view.
Entering into drawdown also requires a high level
of engagement and knowledge from pensioners
that their relative disengagement with the auto-
enroled savings phase has not prepared them for.
Any drawdown strategy can only be appropriate
given an individual’s attitude to risk and capacity
to take risk10
. In the retirement phase this capacity
depends heavily on future expenditure and
income – if you have high spending plans for
your retirement, your capacity to take risk could
be very low. Barclays, in its capacity as a pension
consultant and manufacturer of a best-in-class11
default strategy, along with others may provide
sensible drawdown strategies. However, as plans
change and unforeseen circumstances arise
those strategies will need to be reviewed and
perhaps adjusted.
The choices examined
Despite not knowing the exact content of the
guidance guarantee in the UK we can hypothesize
as to the likely behaviours of those reaching
retirement. Given the pensions regime post April
2015 we think that there will be a few distinct
groups of retirees who will behave in different
ways. At either end of the spectrum, in terms
of wealth, behaviours will be unlikely to change.
People who find themselves at retirement with
small pots previously had the same flexibility
called ‘trivial commutation’, and will be likely
to draw their entire pension as a lump sum.
Bewareofthetaxconsequencesoftaking
yourpensioninonelumpsum
CAUTION LOSSOFPERSONALALLOWANCE CAUTION LOSSOF PERSONAL
CAUTION CAUTION CAUTION CAUTION CAUTION CAUTION
CAUTION HIGHERTAXRATE CAUTION HIGHERTAXRATE CAUTION HI

Those with significant amounts of wealth had
greater flexibility previously, were probably paying
for advice and already had access to a larger
range of products. The biggest effect will be for
employees who have pensions over the trivial
commutation limit of £30,000, but who aren’t
extremely wealthy. They will now also have the
flexibility to take this amount as a lump sum,
though there will be some barriers as a result
of the disincentives from taxation.
The first barrier will be the boundary of higher
rate tax, where any further sum will be taxed at
40%. It is likely that those below this threshold
will find taking the lump sum an appealing
option, given the value of any annual income,
from either annuity or drawdown portfolio, will
feel negligible. This may be used to pay off debt,
provide a cash buffer, or increase retirement living
standards. Above this level, however, the choice
becomes more difficult as retirees will be losing
more of their pension in tax payments if taken
as a lump sum. This group are still likely to see
withdrawing the whole pension as a lump sum
as more valuable than any income stream it can
provide, but may withdraw it over more than one
year to reduce the tax burden. It is worth noting
that some of those with pensions of this size are
likely to continue to work past retirement age
in order to supplement their retirement income.
This could push them into higher rates of
tax earlier, and change the thresholds for
decision-making. The next barrier is the level at
which you start to lose your personal allowance
which is currently £100,000 and finally, those
with taxable lump sums over £150,000 will have
to start paying the additional income tax rate of
45%. It is unlikely that these groups will take the
entire pot as a single lump sum, due to the tax
bill. At this level the income produced by annuity
or drawdown becomes more meaningful and we
are likely to see the benefits of the income stream
being perceived as more valuable than the lump
sum. So, for those with greater wealth, and thus
generally greater risk capacity, a combination of
lump sum and drawdown strategy could well be
the dominant choice. Annuities could be used
with part of the pension pot to provide a secure
standard of living on top of the state pension,
and the rest could be drawn down as and when
needed for other discretionary expenditures.
Lessons to be learnt
Some lessons can be learnt from looking at the
Australian system, by examining the issues they
have faced and what they are trying to do to
improve of outcomes. There has been a trend
towards increased levels of debt leading up to
retirement to boost living standards, with the
tax-free lump sum used to repay the debt. This
is understandable given the consumption-now-
versus-future-consumption trade-off.
8
Goldstein, Daniel G. and Hershfield, Hal E. and Benartzi, Shlomo, The Illusion of Wealth and Its Reversal (January 28, 2014).
Available at SSRN: http://ssrn.com/abstract=2387022 or http://dx.doi.org/10.2139/ssrn.2387022
9
Global Pension Asset Study, Towers Watson, February 2014.
10
Capacity to take risk or risk capacity is defined by an individual’s financial circumstances.
11
Employee Benefit Awards 2014: Best DC pensions default investment – Winner, Jobs and Business Glasgow (JBG Retirement Plan).
15
DRAWDOWN
Income
Pension
Fund

Can you
help me?
Yes
As the guidance standards suggest, seeking financial advice will be
the right answer for many people. Only then will they get the tailored
discussion that most will require in order to fully understand the
consequences of different options and have confidence in their
retirement plans.
What is the right answer?
Advice makes sense for many retirees: those
with only small amounts can’t afford to make
bad decisions and risk their future income; while
for those with larger pension pots, using their
pension in the most efficient way, keeping some
flexibility for future expenditure but not taking
too much risk, will be a complex balancing act.
There is no universal right answer, and the
most appropriate solution will depend on a
combination of individual preferences and
financial circumstances. People will need to
find an appropriate balance in their trade-off
between risk and growth versus income.
The choice now afforded to retirees will
change the ‘at retirement’ allocation that
is most appropriate for the default strategy
significantly.
Withdrawal of the funds as a lump sum may
appear low risk but may have considerable
consequences. It may even be popular as a way
of making the savings pot, which hasn’t been
accessible before, feel tangible. Annuities will
still provide a good answer for many, and
could play at least a part in the best solution
for everyone as insurance against longevity risk.
As life companies innovate in a changed market
and interest rates increase, we may see a second
dawn for the annuity. On the downside though,
neither of these options offers the potential for
growth, which may be important for those who
wish to bequest assets. Having the option of
leaving a bequest is a highly emotional issue,
and for many this will reduce the desire to
purchase an annuity where the money no
longer forms part of your estate at death.
A drawdown strategy may appear to be a
suitable option as members would stay invested
at retirement, but in a portfolio aiming to deliver
an appropriate level of income, either generated
by the investments themselves, and/or by selling
the investments over time. Due to high fixed
costs these types of investment portfolios have
been prohibitive for retirees with smaller pension
pots in the past. For drawdown to become a
feasible option it requires low-cost products
and portfolios.
16

The first steps towards cheaper drawdown
strategies have already been taken. For example,
‘retirement-bridging’ products that provide a
drawdown strategy up until a certain age, after
which an annuity is purchased. A plethora of
other options exists, and no doubt we will see
more product development in the near future.
For most people, using the combination of an
annuity along with any state benefits to provide
a certain critical level of income, with the
remainder in a drawdown strategy, will likely
be the best solution, particularly if the annuity
can be deferred to a later date. The exact
combination depends strongly on levels of risk
tolerance and risk capacity.
Collective defined contribution schemes
Finally, it is worth mentioning collective defined
contribution (CDC) schemes. These are already
used in countries such as The Netherlands and
Canada, and the UK government appears keen
to support their use. These schemes, referred
to as ‘defined ambition’, are a halfway house
between DB and DC. Members’ contributions
are pooled and invested collectively, aiming at a
target for what they will receive at retirement.
They potentially reduce costs, due to their size,
and can help those with smaller pension pots
spread their risk over a broader range of
investments. They are also claimed to provide
better and more stable returns as they distribute
investment and longevity risks over a large
population. However, returns and benefits are
not guaranteed, and the exact returns depend
on the time period observed. It is important to
note that target amounts (indicative amounts
anticipated as retirement income) can, and have
been, reduced in times of economic difficulty. In
The Netherlands there has been a generational
divide on CDCs recently as the young feel they
are subsidising those currently retiring and
missing out on potential growth on their own
contributions. As the UK has an aging population
we may also suffer the same reaction.
There is a relationship between the level of
unionisation of a country and its use of CDCs,
as these sorts of schemes work best if the
members share some common features, such as
demographics and wage growth. This is because
they are treated as a collective with limited
options for individuals to choose contribution
level, risk profile or investment strategy. There are
many barriers to CDCs, including whether they
are better than DC products from a sponsor’s
point of view, as well as concerns around
flexibility. If CDC members are allowed to take
their benefits in one lump sum, this may have an
adverse effect on the remaining members. We
believe it unlikely that employers would support
the seeding of these schemes in the foreseeable
future; employers haven’t been keen to sign up
for them thus far, and they are disillusioned by
the damage done to them from the combination
of uncertain pension liabilities they can’t control
and the several tranches of DB legislation which
have had retrospective impacts.
The importance of the accumulation stage
Ultimately, choices made pre-retirement in
the accumulation stage may be just as, if not
more, important than those made at the point
of retirement. Yet the current guidance is not
designed for this accumulation phase, and
there is a danger that for those who haven’t
saved enough during accumulation, it will not
be able to help no matter how good it is. The
combination of lack of appropriate planning
and individual difficulty in saving enough, early
enough, means that those relying on Defined
Contribution schemes to provide income above
and beyond the state benefits may find them-
selves short of what they need at retirement.
Getting employee pension provision right can
have substantial benefits in the workplace.
17

Robert joined Barclays in February 2011 and has
been a part of the Behavioural Finance team
since 2013.
He bridges the gap between the behavioural
finance and quantitative finance members of the
team. Recently he has spent time working on
mathematical models of individual risk capacity
and how, together with psychological risk
tolerance, this forms the basis for determining
investment suitability. Rob also accompanies
private bankers to client meetings to help
explain our behavioural approach to wealth
management, and presents frequently to
internal and external audiences on the Barclays
Investment Philosophy.
Prior to joining Barclays Wealth, Robert completed
a two-year graduate management programme at
Standard Bank, a South African Investment Bank,
in London. He graduated from Warwick University
with a bachelor’s degree in mechanical and
manufacturing engineering.
About the authors
Robert Smith
Behavioural Finance Specialist
Barclays Wealth and Investment
Management
18

Peter Brooks joined Barclays in March 2007 as
Behavioural Finance Specialist. In this role,
Dr Brooks works with a team of experts to
develop and implement commercial applications
drawing on behavioural portfolio theory, the
psychology of judgment and decision making,
and decision sciences.
In his career with Barclays,DrBrooks has spent over
two years based in Singapore providing specialist
support to the private banking business across
Asia. He supported the launch of the firm’s unique
Investment Philosophy across all key global wealth
management markets and now contributes that
global understanding to clients. He also provides
research commentary on how investor attitudes
are affected by prevailing market conditions and
how this links to investor behaviours. His current
work focuses on bringing the best of behavioural
finance to self-directed investors.
Dr Brooks’ expertise in behavioural finance stems
from his strong background in academia. He holds
a MSc in Economics and Econometrics, and a
PhD in Behavioural and Experimental Economics,
from the University of Manchester. His PhD thesis
focused on experimental research into individual
attitudes to monetary gains and losses.
Dr Peter Brooks PhD
Behavioural Finance Specialist
Barclays Wealth and Investment
Management
Following his PhD, Dr Brooks worked as a
Senior Research Associate in Behavioural and
Experimental Economics at the University of
East Anglia, where his research involved
designing and running experiments on the
ability of repeated market outcomes and
experiences to “teach” individuals to overcome
psychological biases.
Dr Brooks has also contributed research articles
to the Journal of Risk and Uncertainty, Theory
and Decision, and the Wiley Encyclopedia of
Operations Research and Management Science.
He has been a regular contributor to the leading
print and television media on topics related to
investing private wealth.

Barclays is not a legal or tax adviser. Accordingly, nothing contained within this document nor any other material produced by or on behalf of Barclays should be
construed as constituting legal or tax advice to either you (as the employer) or your employees. Tax rules can change and the benefits and drawbacks of a particular tax
treatment will vary with individual circumstances. We recommend that you, as the employer, take professional advice where required. Both you and your employee’s
have sole responsibility for the management of your respective tax and legal affairs including making any applicable filings and payments and complying with any
applicable laws and regulations.
Barclays offers wealth and investment management products and services to its clients through Barclays Bank PLC and its subsidiary companies. Barclays Bank PLC is
registered in England and authorised by the Prudential Regulation Authority and regulated by the Financial Conduct Authority and the Prudential Regulation Authority.
Registered No. 1026167. Registered Office: 1 Churchill Place, London E14 5HP.
February 2015.
DC Pension Investment Consulting.
An enlightened approach from Barclays.
Chances are your workforce is made up of employees from multiple generations,
at different stages of their careers. As such, their needs and priorities will vary
greatly too. With the insights from our Behavioural-Quant Finance team and the
expertise of our DC Consultants you can help your members to invest in a way
that best reflects their needs and helps them achieve their retirement goals.
The full report, Humanising pensions: Understanding the behavioural effects of
freedom in pension choice is available from Barclays:
employersolutions@barclays.com
www.barclays.com/employersolutions
This item can be provided in Braille, large print or audio by calling 0800 400 100*
(via TextDirect if appropriate). If outside the U.K. call +44 (0)1624 684 444*.
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